3M Company (MMM) is a stock that many dividend growth investors love to own, and some have considered it as one of the best dividend growth stocks in the past. The company is one of the premier industrial companies in the US and has a global presence. However, 3M’s dividend safety has declined in the past several years due to rising debt, lower dividend safety metrics, and lawsuits. Despite 3M’s improved capital allocation the dividend safety has declined because of rising risk of losses caused by the earplug and PFAS lawsuits.
3M has 64 consecutive years of dividend growth, making the stock a Dividend King. 3M is only of only nine companies to have paid a growing dividend for 60+ years. Additionally, only seven companies have paid an increasing dividend longer than 3M. The current dividend yield is nearing 5%, and simultaneously the valuation has declined, making 3M is attractive for some investors. However, the company’s stock price will likely face headwinds because of the lawsuits and also recession fears. Although the dividend is safe at the moment, investors should keep on eye on the heightened liabilities from the the lawsuits.
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Overview of 3M Company
3M was founded in 1902 in Minnesota. Today, 3M is one of the largest industrial conglomerates in the US and worldwide. 3M operates in four business segments after downsizing from five. The four business segments are Safety and Industrial, Transportation and Electronics, Health Care, and Consumer. Total sales were $35,355 million in 2021 and $35,085 million in the LTM.
The largest segment by revenue is Safety & Industrial (36% of revenue) followed by Transportation & Electronics (278% of revenue), then Health Care (26% of revenue), and the smallest segment is Consumer (17% of revenue). Revenue was depressed in 2020 due to the adverse impact of COVID-19 but rebounded in 2021 and 2022. 3M’s safety products benefitted from the pandemic. In addition, 3M is a significant global supplier of N95 masks. However, office and industrial closures in Q2 of 2020 negatively affected the Transportation & Electronics segment sales. The Healthcare segment also suffered due to lower elective surgeries. As a result, margins were also negatively impacted in part of 2020.
3M’s notable brands include Post-it, Scotch, Scotch-Brite, ACE, Command, Filtrete, Nexcare, and Futuro. These brands focus on consumer products and health care and are this more well-known. Many of 3M’s other brands target industrial markets and are less well-known to most consumers. Interbrand ranked 3M as the No. 67 best global brand in 2021, impressive for an industrial company.
3M’s Dividend and Growth
3M has paid a dividend every year since 1916, making the company one of the few companies to have paid a dividend for 100+ consecutive years. The company is also a Dividend King since it has raised the dividend for 64 straight years. 3M is also a Dividend Aristocrat and is on the Dow 30 and one of the 2022 Dogs of the Dow.
3M is very popular as an income stock and a dividend growth stock due to its status as a Dividend King. The company has over 175,000 followers on Seeking Alpha, and many articles are related to the dividend. Today, 3M has a dividend yield of approximately 4.75%, more than double that of the average dividend yield for the S&P 500 Index.
The company has long-term dividend growth and acceptable dividend safety. Dividend safety has improved in the past two years and will be discussed in greater detail below. In addition, the COVID-19 pandemic resulted in operational challenges, but the dividend was not cut or suspended, pointing to its resiliency. In general, companies like 3M have a long-term commitment to the dividend.
The chart below from Stock Rover* shows the dividend and growth rate since 2007 superimposed over the stock price chart (in gray). The growth in the regular cash dividend has been approximately 10.7% in the past decade, 4.9% in the trailing 5-years, and 1.1% in the past 3-years. The last dividend increase was only 0.7% to $1.49 per share quarterly from $1.48 per share in February 2022.
Slowing dividend growth is a concern, but 3M had difficulties due to several events in the past few years. First, tariffs and trade wars negatively impacted 3M due to its global footprint. Tariffs are still in place today. Second, high total debt and interest payments also negatively impacted cash flow. However, 3M is better positioned to grow its dividend at a higher rate in 2021 since the payout ratio has declined, total debt is lower, and capital allocation has improved. That said, the company is using cash flow for lawsuits and setting up trusts affecting its ability to raise the dividend by greater amounts.
3M flirted with using debt to buy back shares for several years. This debt drove up total debt and eventually made raising the dividend at a higher rate difficult. In past investor overviews and earnings release transcripts, the company has stated that ~30% of capital to the dividend and was the second priority. Share buybacks are now the lowest propriety behind R&D, dividend, and M&A. This is good from the perspective of future dividend growth.
The forward dividend is currently $5.96 per share, giving a forward yield of about 4.74%. 3M started the year with a lower dividend yield placing it on the Dogs of the Dow 2022 list. The chart below from Portfolio Insight shows the yield history for 3M in the past decade is seen in the chart below from Portfolio Insight*. The average 5-year yield is about 3.21%. The chart below indicates that the dividend yield rarely goes over 4%. It only did so in the past decade during the nadir of the COVID-19 pandemic bear market and again more recently. Before 2022 – 2022, the dividend yield last went over 4% during the bear market of the Great Recession. The current dividend yield has proven to be an excellent entry-level for adding to existing positions or as an entry point.
3M’s Dividend Safety
We will now do a deep dive into three dividend safety metrics: earnings, cash flow, and debt. It is important as a dividend growth investor for all three to meet our criteria. There are often short-term fluctuations that result in a stock not meeting our standards, but those are usually transient and not long-term. The long-term is essential for dividend growth investors who can capitalize on short-term variation to dollar cost average or buy the dip. Now, let’s do a deep dive into 3M’s dividend safety.
Adjusted non-GAAP earnings cover 3M’s dividend. In fiscal 2021, 3M earned $10.12 per share and paid a dividend of $5.92 per share, giving a payout ratio of about 58%. This value is less than our target value of 65% and payout ratios below this number is excellent for dividend safety and dividend growth.
Looking forward, consensus fiscal 2022 earnings per share is $10.39, and the forward dividend is $5.96 per share, giving a payout ratio of approximately 57%, which is reasonably conservative.
That said, dividend coverage is a little bit lower after accounting for extra items. The additional items vary year-to-year and typically charge for mergers, restructuring, and asset sales. However, the dividend is covered by diluted earnings in each year in the past decade.
In addition, the dividend is well covered by free cash flow. On a trailing basis, operating cash flow was $7,454 million in 2021 based on data from TIKR*. Capital expenditures were $1,603 million giving a free cash flow of $5,881 million. The forward dividend requires about $3,397 million ($5.96 x 570 million shares). Assuming a similar FCF in 2022 as a low-end estimate, the dividend-to-FCF ratio is about 58%, which is relatively conservative and below our threshold of 70%. It is good that in a challenging year, 3M’s dividend coverage by free cash flow is still solid.
For perspective, the cash flow required to pay the dividend has more than doubled from $1,555 million in 2011 to $3,420 million in 2021. The share count has declined by over 110 million shares in the trailing ten years. Before the current CEO, 3M was buying back billions of dollars in shares per year but using debt. Share repurchases have been reduced and are based on cash flow. For perspective, it was over $5 billion from 2013 to 2015 and over $2 billion in all other years in the past decade.
3M’s total debt was a concern, but it is now declining. A decade ago, 3M had total debt of about $5 billion. It increased by 4X to $23,342 million by Q1 2020. Then, net debt was $18,848 million. Since then, total debt has declined to $17,196 million at the end of Q2 2022, and net debt has fallen to $14,212 million, according to data from Portfolio Insight*. In addition, cash, equivalents, and short-term investments were $2,984 million. Lower debt is a very positive development from the context of dividend safety and dividend growth.
3M’s interest coverage declined for over 30X a decade ago to a low of 13.4X in 2020. Interest coverage is now trending upward at 14.1X in the LTM. The leverage ratio was a minuscule 0.09X a decade ago and peaked at 2.06X in 2019. The leverage ratio is trending down now and is 1.57X in the LTM. The current trends for both interest coverage and leverage ratio are good ones.
On a negative note, 3M’s credit rating is A1 from Moody’s and A+ from S&P Global. These are investment-grade credit ratings, and 3M can meet its obligations. However, the credit ratings are lower than in 2019 due to lower revenue and earnings and higher leverage than in the past.
3M’s dividend safety was declining due to significant increases in the dividend and rising debt until about two years ago. However, the dividend safety metrics have improved, and total and net debt has declined. As a result, overall dividend safety is excellent now. Currently, the metrics do not indicate that the dividend is at risk. However, investors must keep in mind that the lawsuits for earplugs and PFAS are still ongoing and may impact the dividend in the future.
3M faces roughly 230k+ lawsuits related to the company’s earplugs sold to the military, making it the most significant multidistrict litigation (MDL) in US history. To date, 16 test cases have been litigated, with ten wins for the plaintiffs and six wins for the defense or company. Although the plaintiffs have won more cases, they have not won all cases; hence, settlement negotiations have not started. However, the federal judge presiding over the lawsuits ordered mediation to prevent the overwhelming of the federal courts. Extrapolation of the awards for the plaintiffs could mean billions in losses. There is much legal maneuvering beyond the scope of this article, and the outcome is uncertain.
The second set of lawsuits impacting 3M is the PFAS lawsuits. The term PFAS is short for per-and poly-fluoroalkyl substances. They are some of the most persistent chemicals discovered and used in products like Teflon and Scotchguard. PFAS chemicals do not naturally break down, potentially accumulating in the soil, water, and blood. These lawsuits are also in an MDL in the US federal courts. But lawsuits also exist overseas. 3M is litigating the cases and has settled some resulting in charges. But, again, the issues are beyond the scope of this article, and the outcome is uncertain.
Final Thoughts on 3M (MMM) Dividend Safety Analysis
3M is a popular stock for dividend growth investors to own since it is a Dividend King and has a decent yield historically safe. However, dividend growth has been low for the past 3-years and 5-years. I attribute this to poor capital allocation in the recent past, rising debt, and operational challenges. In addition, as mentioned above, 3M has been faced with tariffs, trade wars, and adverse effects of COVID-19. However, the company has lowered debt and improved the interest coverage and leverage ratio in the past two years. As a result, dividend safety has improved.
That said, risks to the dividend because of the earplug and PFAS lawsuits has risen. The company is facing many cases related to its earplugs with no near-term resolution. Similarly, the PFAS liabilities are still being litigated. Both lawsuits are causing the company to spend money on litigation and to set aside funds for future liabilities. However, the dividend is not immediately at risk, but dividend growth may be much slower in the near term. Additionally, revenue, earn gins, and free cash flow may be impaired. Consequently, I have exited my position in 3M because it meets some criteria to sell a dividend stock.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.